The present invention relates to stimulating liquidity in financial markets, and more particularly, is directed to providing insurance that an order submitted to an order matching process will be matched.
In an order match process, buy and sell orders are accumulated for a period of time, and then the accumulated orders are matched. The accumulation period may be time driven, that is, matches occur periodically, or volume driven, that is, matches occur when a predetermined volume of orders have been accumulated, or some combination thereof.
The price at which the orders are matched is typically determined by reference to an external price, that is, a price from another market. For example, the price in the external market at the instant that the match occurs can be used. More specifically, prices are usually quoted as a pair: a bid price and an offer price. In the simplest case, the midpoint of the bid-offer quote is used as the match price.
For some trading instruments, prices can vary greatly during a trading day; this characteristic is referred to as “price volatility.” A so-called daily volume weighted average price (VWAP) metric has been defined as the value of all transactions in a trading day divided by the number of shares traded. Traders are often evaluated based on how far the price they obtained deviates from VWAP. By splitting an order into smaller orders that are executed periodically during the day, a trader can artificially mimic a VWAP price. Typically, trading volume peaks at the opening and closing of the trading day, is minimal around lunchtime, and is intermediate at other points.
POSIT is an electronic equity-matching execution tool offered by ITG Inc., New York, N.Y. Buy and sell orders, including both individual stocks and portfolios, are entered into the system from many sources. Eight times daily—9:40, 10:00, 10:30 and hourly from 11:00 to 3:00 Eastern Time—the POSIT computer processes and compares all orders confidentially. For maximum security, each match is run at a randomly selected time within a five-minute window immediately following the scheduled match time.
POSIT trades are priced relative to the stock's primary market at the moment the match is run. Trades are matched at the midpoint of the bid/offer spread. Those order which match are automatically executed. Immediately after each match, clients receive electronic reports showing match results for their orders. Clients then decide whether to keep unmatched orders in the system for future matches or to execute them by other means.
POSIT touts its advantages as: (i) confidentiality that eliminates unfavorable market impact resulting from trading in an open arena, (ii) low commission costs due to a highly automated infrastructure, and (iii) mid-point pricing enables users to save half of the bid/offer spread.
The so-called POSIT 4 system enables matching stocks based on characteristics rather than stock name alone, providing the possibility of improved liquidity, reduced transaction costs and reduced risk. This dynamic substitution and risk control capability can be used for:                contingent orders, such as, “If the ratio between the match prices for ‘ABC’ and ‘XYZ’ is greater than 1.2, then buy up to $100,000 of ‘ABC’ and sell short an equivalent number of dollars of ‘XYZ’, maintaining the dollar balance to within one round-lot. But if I cannot get at least 1000 shares of each name done, I don't want to make the trade.”        sector balancing, such as, “I use the BARRA industry group definitions and my universe is the Russell 1000®. I currently hold the following allocations: oil $10 MM, paper $5 MM, aluminum $5 MM, and would like to move into: oil $7 MM, beverages $8 MM, cash $5 MM. I will only trade if I can get a minimum of $1M in total done in the match with no less than $10,000 traded in any single name.”        principal guarantee bid, such as, “I have a two-sided list that I eventually want to send out for bid. The bid dollar imbalance and the total risk are high and the bid will be expensive. I want to do some advance trading in POSIT to reduce the costs of the bid, but will trade only if it will reduce or at least not increase the list's risk and dollar imbalance. All things being equal, I want to trade illiquid names before liquid ones.”        index fund management, such as, “My portfolio tracks the Russell 1000%, and my current tracking error is too high. I will trade any Russell 1000 name that will reduce my tracking error, so long as I trade at least $10,000 of any single name.”        
ITG suggests a “VWAP Strategy” to assist in executing portfolios using the VWAP benchmark. Step 1 is to identify eligible VWAP orders. Orders that would be more appropriately traded by other means, such as illiquid blocks and most OTC names, are separated from the portfolio during a pre-trade analysis. Cost estimates against the VWAP benchmark are generated for the remaining portfolio using a proprietary pricing algorithm. Step 2 is to employ intelligent volume distribution. Trade volume is distributed over the day using historical volume data to recommend order sizes to be traded at the open, the close and each of the 12 half-hour intervals during the trading day. Step 3 is to maximize price improvement using intelligent trading rules that dynamically adapt to market conditions to determine the best way to trade the shares within each time interval. Proprietary limit order setting rules are systematically applied to maximize price improvement during the day based on market conditions. The strategy automatically routes orders to POSIT during trading intervals that correspond with one of the eight regular daily POSIT matches. Residual orders are returned to the VWAP execution list. Step 4 is to analyze results using reports with varying time horizons. VWAP trades are executed on an agency basis, with a choice of either a fixed commission or an incentive pricing arrangement.
A VWAP SmartServer is operative to transmit orders to multiple markets including POSIT. In response to portfolios from users, the SmartServer creates, monitors and executes orders based on expected volume patterns and current market conditions.
A problem with order matching processes is that there is usually a market imbalance, that is, more volume on the buy side than the sell side, or vice versa. Accordingly, only a small percentage of orders are actually matched. Historically, the match rate was around 10%, meaning one in ten orders matched, which is a low liquidity. POSIT has achieved slightly better performance. Knowing that the match efficiency is low, parties refrain from submitting their orders to the match process, further reducing the liquidity of the process.
Thus, there is a need for a way to stimulate the liquidity of the match process.